Make no mistake about it—the government is raising taxes to cover their excessive spending, and not managing your income taxes can cost you thousands of dollars per year. I had a client who set up their business using the wrong business entity. This increased their taxes by thousands of dollars every year. By simply correcting how their business was structured, I saved them $45,000 this year. This isn’t just a one-year savings. Restructuring will continue to save them this amount every year. If they stay in business 10 years, that’s $450,000 in savings. In 20 years, they will have saved $900,000 that they would otherwise have paid the IRS just by having the wrong business structure! I’m sure they can find something better to do with that money.
- Know the basic rules of income tax liability. Find out what’s nontaxable, and figure out a way to earn as much as possible. The general rule is that if you don’t find a place in the code that says nontaxable, then it’s taxable.
- Shift income to later years. This is most often accomplished with a tax-deferred retirement plan or annuity or collecting receivables in January instead of December. It’s based on the concept that while you’re in your peak earning years or while your business is really kicking off a bunch of income, you get shifted into a higher graduated tax bracket. The idea is to not have all of your income taxed at the highest possible tax rate. You’re going to shift it to years when you’re not working as much and probably won’t have as much income.
- Accelerate deductions. Review your income statement to see what items you can pay before year end. Buy equipment that you are considering purchasing early in the next year before year-end. Be sure to check with your tax advisor.
- If you expect your income to be higher next year, reverse number 2 and 3 above—accelerate income and postpone deductions. The goal is to use the tax rates to pay less in both years combined than you would if you had done no tax planning.
- Shift income to taxpayers in lower tax brackets than yourself. This can be between you and other family members or between you and a C Corporation. Warning—don’t forget the “Kiddie Tax” implications.
- Turn after-tax expenditures into tax-deductible items. I had a boss once who said every taxpayer should own a peanut stand or a popcorn stand. What he meant was that everybody should have some side business, even if you’re a wage earner, which allows you to deduct things that you normally would buy anyway on an after-tax basis.
- Take advantage of as many adjustments to income, deductions, and tax credits as possible. There’s no real magic trick here. You just have to know what is available to you. Tax preparers are not mind readers. We’re going to ask you lots of questions, but you might have something out of the ordinary. Believe me, there are hundreds of thousands of tax deductions, and we’re not just going to put all of them on your tax return! And no client is going to sit still long enough for us to ask about every single possible deduction that they might qualify for. As tax preparers, we are only going to ask about the most common ones.
- Choose the right business entity for your particular business. As a general rule, real estate should not be held in a C Corporation. Profits from a future sale would be taxed twice—once at the corporate level and again at the individual level as dividend income, when the money is taken out of the corporation. Almost all real estate is held in an LLC and taxed as a partnership.
Normally, though, between 85 and 90 percent of small businesses are set up as S-Corporations for two reasons:
- It eliminates the double taxation discussed above. If I have a business in a C Corp and it really does well, the IRS says I can’t take profits out. I can only pay myself a fair salary. The excess must be distributed out as dividends and taxed a second time at the individual level.
- An S Corporation allows you to reduce Social Security and Medicare tax payments to the amount of the owner’s salary rather than the total profits of the company. Warning: The owner must receive a fair and reasonable salary. The IRS is auditing S Corporations that pay little or no salary to the owner.
- Hire your family members. You’re most likely going to pay your children allowance anyway; you might as well have them work for the money so you can deduct the payment. You’ll also be teaching them some valuable lessons. I did this with all three of my kids. They’d come in and do some filing, answer the phones, or run errands. Now they must actually be working. You can’t just give them money. And you’ve got to give them a fair pay.
- Set up a medical reimbursement plan (MRP/105 plan). Healthcare costs are only deductible as an itemized deduction if the amount out of pocket exceeds ten percent of your income. This greatly reduces the amount that high-income earners or taxpayers who don’t normally itemize can deduct. One way to deduct medical bills in full is by setting up a medical reimbursement plan. It’s kind of tricky and requires quite a bit of planning, so consult your tax professional before setting one of these up.
- If a medical reimbursement plan isn’t appropriate or is too expensive due to a high number of employees, consider setting up an HSA. The amount you can deduct has been reduced to $2,500 because of ObamaCare, but it’s still a pretty powerful way to deduct medical expenses.
- Take advantage of a home office deduction. This deduction is probably the most misunderstood deduction in the entire tax code. For years, it was an IRS red flag. Now it’s much less likely to be an issue because there are certain steps you have to go through. It must be either your principal place of business or a place to meet with customers in the normal course of business. You may also deduct a home office if the space is a separate structure detached from your residence but used in connection with the business.
- Consider renting your main home or your vacation home to your business for less than 15 days. Your business can deduct the rental and you will not have to report the income personally.
- Document all of your meals and entertainment. If it isn’t documented and you are ever audited, an IRS agent will disallow the deduction. For each expenditure you will need the date, amount, and business purpose of the expenditure, as well as who attended. The best thing to do is to take the receipt and write all of this information on the back. Scan the receipt and then toss it, because these receipts from restaurants are notorious for fading away. By the time you need it two or three years from now, you won’t have it.
- Pay property taxes in December, not January. Pay your January 2016 rent or building payment in December 2014.
- Look into creating a retirement plan. The vast number of tax-deductible retirement plan options makes this a subject well beyond the scope of this article. There are many options available to business owners, so call your CPA for more information.
- Year-end hiring equals savings. Take advantage of the small employer health insurance credit. It’s one of the few things that really does helps small employers under ObamaCare. The credit is worth up to 50 percent of the premiums paid. This is very tricky to calculate, so get a tax professional to help you.
- If you’re going to buy equipment, do it soon. The Section 179 deduction for 2015 is currently only at $25,000. But the house has passed a bill to increase it to $500,000. This will have to be watched very closely and tax planning will more complicated. Last year the bill was passed late in December and was applied retroactively.
- Buying a heavy pickup or SUV in 2015 can result in a big tax write-off.
- Be sure to calculate your auto deduction under the actual cost method and the mileage method, and then deduct the amount that is best for you. As a general rule of thumb, if you drive more than 14,000 miles a year for business, you’re probably better off using the mileage method.
- If you have losses in a partnership or an S Corporation, be sure you have enough basis to deduct them. In English, that means enough investment. If you’re liable for a loan personally, that counts. In a partnership, a loss is only deductible to the extent of your basis—your investment in the partnership. An S Corporation shareholder can only deduct his share of losses up to the amount of the basis and debt owed to him by the corporation.
- Write off your bad debts. If you’re on a cash basis, this won’t work because you didn’t collect the funds. Truthfully, there are a lot of good advantages to being on an accrual basis, unless you’re a doctor or dentist and you have a lot of write-offs. Even then I argue you’re probably better off if you’re pretty strong about writing off your bad debts.
- Write off your old inventory. I just talked to a client who hadn’t written off bad inventory in 10 years! He finally wrote it off only because he didn’t want to pay the property tax. Review your inventory. You could do lower cost of market. Even if it’s not bad, if it’s worth less than you paid, you can take a write-off.
- Donate old computers, other equipment you no longer use or inventory. You can write off one-half of the difference of the fair value less your remaining basis, which is your original cost less depreciation. You probably wrote off most of this equipment all at once, so what we’re talking about is one-half of the fair market value. Go on eBay, see what its worth, and give it away. It’s better than nothing.
Like any good CPA, I need to add a disclaimer: Unfortunately, it is impossible to offer comprehensive tax info over the Internet, no matter how well-researched or written. And remember, I love my readers, but reading this article or watching this video doesn’t make you a client: Before relying on any discussed here, contact a tax professional to discuss your particular situation.